Own-company stockholding and work effort preferences of an unconstrained executive

We develop a framework for analyzing an executive’s own-company stockholding and work effort preferences. The executive, characterized by risk aversion and work effectiveness parameters, invests his personal wealth without constraint in the financial market, including the stock of his own company whose value he can directly influence with work effort. The executive’s utility-maximizing personal investment and work effort strategy is derived in closed-form, and an indifference utility rationale is demonstrated to determine his required compensation. Our results have implications for the practical and theoretical assessment of executive quality and the benefits of performance contracting. Assuming knowledge of the company’s non-systematic risk, our executive’s unconstrained own-company investment identifies his work effectiveness (i.e. quality), and also reflects work effort that establishes a base-level that performance contracting should seek to exceed.